Abstract
M.B.A.
A share buyback scheme is a situation where a company buys back its shares from
shareholders and then cancels them or creates treasury shares. The Companies
Act, 1973 (Act 61 of 1973), previously limited the reduction in the number of shares
to preference shares which could only be redeemed by a transfer of the equal
amount to the capital redemption reserve fund, a non-distributable reserve in order
to maintain the capital levels.
Section 85 of the Companies Act now allows a company to buy back its ordinary
shares and cancel them without replacing them with a capital redemption reserve
fund. The only requirement is that the company must prove that they will be liquid
and solvent after undertaking such a share buyback. This has far-reaching
consequences for the creditors who rely on the capital maintenance rule as the only
protection afforded to them should the company go bankrupt.
The reduction in the number of shares after the share buyback also creates
problems. Firstly, the company's operating capabilities can be reduced, damaging
the remaining and future shareholders and secondly, the company's earnings per
share (EPS) can improve without any improvement in the actual performance. This
tends to make the Annual Financial Statements (AFS) unreliable as the users still
rely on the EPS for an indication of whether the company is growing or not.
Companies use a share buyback for various other reasons, the most important of
which being that they want to distribute excess cash back to shareholders. Some of
these companies, however, go back to the lending houses to borrow money to
finance their current operations immediately after the share buyback.
It is imperative to investigate the real reason why companies undertake a share
buyback and what effect this has on the profitability and the earnings per share of
listed companies in South Africa.